How Central Banks Destroyed The Middle Class

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Misguided central bank policies have been greatly counter-productive and harmful.

Zero and negative interest rates lead to deflation, not inflation.

Yield-chasing asset price bubbles will likely soon burst, resulting in bear markets.

Hypothetically, this might be the front page headline to the economic analysis column in the Wall Street Journal of Wednesday, June 30, 2021 - five years hence.

Here's what the story covers:

The global recession of 2017-19 was caused by the well-intentioned but deeply flawed policies promulgated by the world's leading central banks - the Fed, BoJ, ECB and PBofChina. The banks were all led and supported by large staffs of professionally trained economists and bankers who tried to prevent and then dodge a recession by deployment of Keynesian theories, which always sound good on paper but don't work in practice because the debts accumulated in the bad times are never liquidated in the good times. The benefited/subsidized kids always scream when someone tries to take their "lollipops" away. And so the ability and will to reduce debts were absent.

Fiscal policies were also never easily implemented because of political polarization and paralysis, pretty much across the board, in all countries and regions.

Measurement of inflation rates and targets was greatly misleading. For example, the Fed's preferred CPI numbers had over a long time consistently understated the "real-feel" inflation that most middle-class consumers experienced when they bought basic foods and fuels and spent for insurance, college tuitions, medical services and other day-to-day essentials. Real-feel inflation is like wind-chill readings in the winter or heat-wave warnings in the summer. The August temperature is 90 deg F, but with the high humidity it feels like 110. In this way, the central banks were being misguided by their own faulty and politically manipulated metrics.

Central banks such as the Fed claimed that policy-action transparency via press conferences and earlier releases of meeting minutes was clearer than ever. But actually, the central banks were making it all up as they went along. Central bankers had a habit of moving the goal posts, too. First, rate hikes were to be implemented in the U.S. at a 6% unemployment rate. But by May 2016, with the rate under 5%, the Fed was still hesitant.

The financial media didn't adequately question central bank pronouncements. For example, the media endlessly echoed that any rate hikes would be "data-dependent." Yet in the 102-year history of the Fed, there had never ever been a policy decision that was not "data-dependent."

Another failing of the media was to accept without question the notion that the much-desired target of a 2% annual inflation rate was just what the doctor ordered. But at 2% inflation, geometric extrapolation over 10 years suggests that the average person will lose at least 20% buying power. So even at a mere 2%, the middle class worker/saver trying to stay solvent and doing the "right" thing for family and fortune was actually going broke!

By going to zero or negative interest rates (ZIRP and NIRP), the true market prices of risk and equity and bond prices were not only distorted, they were largely unknown. The market couldn't function through proper price discovery mechanics. So companies didn't buy new equipment, economic productivity stagnated and the public was so uncertain about the future that, wherever possible, they stopped spending - doing just the opposite of what the central banks said they wanted. ZIRP thus actually caused the very deflation that the central banks were trying to prevent. The policies also turned out to weaken and undermine rather than strengthen commercial bank balance sheets.

Moreover, despite the creation of numerous global yield-chasing asset price bubbles, as stimulated by the central bankers, pension funds and insurance companies could not even come close to meeting their obligations to retirees. As a result, some funds could not be sustained and retirement payouts had to be reduced or entirely eliminated.

There had already by 2016 been lots of hand-wringing about income inequality (e.g., as seen in the presidential election rhetoric). But the cruel truth is that ZIRP or NIRP exacerbated income inequality. Prices for bonds, stocks and real estate bubbled up, while regular-guy incomes could not keep up with "real-feel" inflation.

And while top corporations could borrow all they wanted at near zero rates and could buy back billions of dollars worth of shares with abandon, small businesses were choked. Regulations on top of regulations and wonderful-sounding upward adjusting minimum wages killed jobs and nipped new enterprises in the bud. The $15 an hour minimum wage proposals only accelerated the replacement of people with robots and led to small-business closures.

Central banks tried hardest of all to avoid debt deflation and the nasty economic consequences that followed. But they only moved the problem further out in time and allowed the debt mountain to grow even larger - in fact well beyond the ability of the major economies to service the obligations out of real economic earnings and cash flows.

The policies clearly didn't work. The ECB ran out of sovereign bonds to buy, the BoJ ended up buying equities, and it is still not known precisely what the PBoC did except for paddling furiously in trying to keep the Shanghai Composite afloat and Chinese real estate from crashing. Central bankers all ended up being powerless to offset the 2017-19 recession, which none of them had anyhow been able to accurately predict.

The WSJ article of June 2021 thus concluded that the world's major central banks were instrumental in wiping out the middle class in the US, Europe and Asia and that it will likely be many years before the world's economies recover.

From mid-2016 onward, it would have thus appeared that the market's upside potential reward was much less than its downside risks. And in retrospect, the best advice at that time would have been to short the S&P 500 (NYSEARCA:SH) or other major market indexes on any and all rallies.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.